Global Margin Call
By Paul Lamont
December 31, 2009
As we reported last month, individual investors are “pouring money into mutual funds that buy foreign stocks, especially in emerging markets such as China and India.” It appears that UK investors are joining the party. Not surprisingly, stories of the Chinese bubble are starting to come in. As typical of the top, investors feel that nothing can “change the upward trend.”
There are many risks when investing overseas. As we mentioned in Crash Opportunities Part 2, we prefer to invest when we “see a torrent of horrible news coming from these countries.” This way your funds will ride the wave of recovery. Now we are in an inverse situation; so avoid emerging markets like the plague.
Not only are optimistic individual investors rushing into the next underperforming investment, but according to Investment Intelligence Advisors’ Survey, investment advisors (who should know better) are the most bullish in 22 years.
As Elliott Wave International relates:
“At just 15.6%, the percentage of bears is the lowest in 22 years, since March 1987. (II notes that it is the lowest since April 1987, but our spreadsheet shows it's the lowest since the final week of March. Either way, it is an extraordinary drop.) It is lower than at the October 2007 peak, the January 2000 peak and the August 1987 peak, prior to the crash.”
Since excessive optimism is the fuel for bear markets, we continue to expect an Acapulco Cliff Dive. Now that we have muddled through the low volume Holidays, we expect to resume trading to the downside in January.
The Dollar Rise and Holiday Margin Calls
In September, with outright panic in the U.S. dollar we called for an uptrend to begin. It looks like we are in good company, as Jim Rogers recently stated:
"Over the past couple of months I have been accumulating U.S. dollars...because there are too many bears. If and when the crisis really hits, the dollar will rally. I am expecting some kind of rally in the dollar. If it does rally for a quarter or year, I will sell it. If it doesn't, I will probably panic and sell it as it goes down, along with everyone else." – Jim Rogers in Reuters Investment Outlook 2010 Summit
Dr. Marc Faber also noted:
“…this weak dollar-strong emerging markets and out performance of emerging markets has become so widely accepted by investors around the world, that we could also have for a change a strong U.S. Dollar or rebounding dollar…” – Marc Faber, Bloomberg.
As you can see from the chart below, despite the news of a collapse, the U.S. dollar did not even make a new low. In July 2008, losses that were “inexplicably larger than what people expected” at Merrill Lynch and Citigroup kicked off the dollar rise. We all know what happened that fall. We suspect that the continued rise in the U.S. dollar will correspond with similar margin calls and financial losses.
Where Are the Surprise Losses This Time?
On Christmas Eve, the Treasury department announced an unlimited bailout of Fannie Mae and Freddie Mac:
“…the promise of unlimited government money ‘should leave no uncertainty about the Treasury's commitment to support these firms as they continue to play a vital role in the housing market during this current crisis.’”
With only 30% of pledged bailout funds currently being used at both institutions it’s no wonder that analysts are finding
“the extra support ‘perplexing’…because Fannie and Freddie are unlikely to need more than $200 billion of government money each.”
From Firesale Prices to Reality
During much of the crisis, bankers have lamented the ‘firesale’ prices placed on mortgage securities. It turns out these were real prices all along. As Marketwatch goes on to explain: “…Fannie and Freddie hold mortgage securities in their portfolios at original cost. So write-downs from principal reductions could "meaningfully impact earnings and capital.” Any hiccup in the lending at these institutions, because of their size, will further depress housing prices creating more losses at financial institutions.
“I have several reasons to question the notion that the Kondratieff wave has already turned up. For one, according to Schumpeter, the decline in the cycle continues – and this is important – below the point of equilibrium, and only when the debt structure has been restored to a sound basis will the economy again reach its point of equilibrium. At present, there is nobody who would claim that the debt structure has been restored to a sound equilibrium. In fact it is getting worse by the day as debt growth exceeds economic growth rates in most industrialised countries and as the U.S. economy is supported by a growing housing and consumer credit pyramid.” – Dr. Marc Faber. Tomorrow’s Gold, 2002.
Get Out The Door
A few weeks ago, a man asked us
about the stock market. Instead of boring him with technical and sentiment
figures, my response to him was this:
We like to leave the party when the Rolling Stones arrive.
Sure, that's when the real fun starts. The music is good. The drinks are flowing. What a party! You think how lucky you are not to be at home alone. But pretty soon, you can't find the door. Most never leave.
Have a Happy New Year! 2010 should
be very interesting.
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